The economics of gifting Cadbury explained

The monetary consideration involved in gifting gives rise to a whole industry that thrives on people gifting each other gifts that have materialistic touch about it. However, hard we may decry the economics and materialism involved in gifting it would be difficult for us not to be happy when we get gifts. We are in the middle of the peak season of gifting. Diwali is around the corner and this is the time when we exchange the maximum gifts in India. India is an important market for the multinational companies as along with Brazil, Russia and China they have captured approximately 45% of the market.  So let us now understand what the big pain point is for these chocolate companies using Cadbury India example

What are the factors we need to look at to estimate the profitability of these companies through sales of chocolates?

·         Total Sales - (Product of Selling Price and Units sold)

o   Ability to increase the selling price of chocolate depends on the responsiveness of change in quantity demand. It is expected that the price of certain high end chocolates such as Cadbury Dairy Milk Silk and Bournville should increase as the demand for these chocolates are inelastic, hence increase in price does not lead to decrease in quantity demanded..

o   The demand (units sold) for chocolates peaks in the seasons when there is festivity. Hence, October to December is the best quarter for the company. The increase in demand might also be attributed to increase in total online gifting.

Cost of Raw Material: As can be seen from the table below raw material as % of sales has increased over the years.

              Table 1 - Cadbury India – Raw Material to Sales

              

Particular (INR Cr.)	Dec 2012	Dec 2011	Dec 2010	Dec 2009	Dec 2008	Dec 2007	Dec 2006
Net Sales	4,065.98	3,364.65	2,503.24	1,934.38	1,588.59	1,293.47	1,058.24
Raw Materials	1,576.33	1,247.80	903.81	617.29	522.06	394.55	295.95
Raw Materials as % of sales	39%	37%	36%	32%	33%	31%	28%

Source: Capitaline

The table above finds the ratio between cost of raw materials and sales for the FY 2006 to 2012. As the cost of raw material to sales has been more than 25% it can be deduced that that cost of raw material is an important cost for the company. The other conclusion that we can arrive at is cost of raw material has been eating into the potential profits as it has increased in proportion from 28% to approximately 40% .

Now the important question is why is cost of raw materials increasing?

The cost of raw materials is increasing primarily because the cost of cocoa which is an important ingredient is going up. The reason why the price of cocoa is going up is that there is a mismatch between demand and supply with demand outstripping supply. Hence, one alternative for manufacturers of chocolate is to reduce cocoa content and increase artificial ingredients. The other alternative is to decrease the size of the chocolate bars and keep the price same. I believe most companies would prefer decreasing the size of the bar rather than impacting the taste of the chocolate.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +

PVR Cinemas sells off Anupam, South Delhi Cineplex and Leases it back - explained

PVR, one of the most popular chains of cineplexes in India has of late sold Anupam, one of it's flagship  cineplex, situated in South Delhi, to an undisclosed party for Rs. 52 cr. This news would have been noticed by all those Delhites who have seen movies at PVR Anupam. However, it is not the selling of Anupam cineplex that has evoked interest from the analyst community. The fact that the buyer has leased back the asset to PVR is what has evinced interest. So what are the financial ramifications of this transaction is the question that I try and explain the readers of the blog. 

Let us see how the financial statements are being impacted by the news. If you are not clear with your financial statements you could just read the paragraph below. If you are a pro just ignore it.

There are three financial statements that companies essentially prepare:

1. Income Statement - Aimed at arriving at the profit the company earns in the given accounting period
2. Balance Sheet - Aimed at calculating the solvency (long term debt paying ability) and liquidity (short term debt paying ability) position of the company as on a given date.
3. Cash Flow Statement - Aimed at arriving at the cash balance at the end of the year. It is divided into three parts cash flow from operations (money generated from operations) , cash flow from investing (money spent on buying assets net of assets sold) and cash flow from financing (money raised for business net of money returned to investors,lenders etc.). 

When cineplex is sold  for Rs. 52 cr. in cash what happens to the financial statement?

Balance Sheet: Operating non current asset (long term asset which help earn revenues) decreases in this case  and cash (which is a part of short term asset increases) . Thus, the company's operating profit generating capacity decreases as it's operating non current asset decreases and hence if we look in isolation the company has contracted in size.  

So here is how the balance sheet would be impacted by the transaction when it comes to PVR Cinemas Ltd.

PVR Fixed Assets (A)	Impact	FY 2013	FY 2012	FY 2011
Gross Block	493.57	545.57	385.37	353.24
Less : Accumulated Depreciation	230.78	181.68	143.60	112.84
Depreciation (As shown in Income Statement)	49.10	42.95	31.36	24.11
Net Block	262.79	363.89	241.77	240.40
Depreciation Rate	9%	11%	9%	9%
Cash (B)	72.63	20.63	12.55	35.12

Source: Capitaline.com, PVR Annual Report 2012,2013

Hence, as can be seen in the table the Net Block of Property, Plant and Equipment will reduce while Cash has increased.

Cash Flow Statement -

• Cash Flow from operations would decrease/ increase depending on the lease agreement
• Lease Expenses would appear as an operating expense; cash flow from operations would decrease.

• Cash Flow from investment would increase as sales of asset would bring in cash.

Income Statement

Operating Profit (EBIT) would also depend on the lease agreement as in the case of 

• Lease Expenses would appear as an operating expense
• Depreciation expenses would decrease by approximatelty Rs. 5.1 cr. (10% of Rs. 52 cr.). Rate of depreciation is based on historic depreciation rate.

Impact on the stock price:

The markets have  reacted favourably to the news as even though technically assets have decreased, the company still reaps the benefit of assets. With decrease in assets, return on asset and asset turnover ratio has improved. The price of the stock has moved up from  Rs. 485 to Rs. Rs. 515 in 3  days of trade.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +

   

Asset Liability Management explained using Yes Bank example

A lot of people want to understand what the cause of woes of Indian bank is. Here is my attempt at demystifying the asset liability mismanagement 

1.     What does “asset liability” in the term asset liability management imply?

Asset for a bank in this case refers to assets that generate interest and liabilities are those on which we pay interest. Hence, assets would primarily include loans and advances given by bank and interest generating investments. On the other hand, liability would include deposits and loans and advances taken by bank  to finance their investment.

2.     So what does asset liability management imply?

Here the assets are primarily funded by liabilities. Example, the loan that the bank grants you for your house may be funded by the deposit that people make in their accounts or the loan that the bank takes to fund the assets.

Asset Liability Management refers to the process of balancing tenure of assets with the tenure of liability. Tenure refers to the period for which the money is lent and borrowed. Ideally, a short term asset should be financed with a short term liability.

3.     Why do we need to match the tenure for assets and liabilities?

We need to match the tenure of the loans because the rate of short term and middle term assets and liabilities (1-5 years) change at a faster rate compared to change in the rate of interest of loans which are long term assets. For example, if the base rates change the banks are forced to increase deposit rates on short term and medium term deposits. However, interest rates on loans which are of longer tenure do not increase in hurry on the other hand.

4.     So how does it impact the income?

It impacts the net interest income negatively, whenever interest rates go up. The interest income remains constant, while interest expense increases as re-pricing of bank assets take longer than pricing of bank liabilities. (Re-pricing is

technical term for adjustment of interest rates.)

5.     What are the interest rate expectations in the future?

Banks fear that the interest rate might go up as the inflation rate is at all-time high. RBI ideally uses interest rates as a tool to control liquidity. According to a recent survey done by Reuters unexpectedly high inflationary pressure has led to analysts expecting higher interest rates.

6.     What are asset liability buckets?

Asset Liability bucket refers to the process of dividing assets and liabilities based on their tenures. Following is the asset liability maturity bucket of Yes Bank Ltd.

	Assets			Liabilities
Maturity Buckets	Loans & Adv	Investment	Total Assets	Deposits and Securities	Borrowings	Total Liabilities	Net Assets
1 day	2,211,941	-	2,211,941	5,968,491	-	5,968,491	(3,756,550)
2-7 days	6,687,905	-	6,687,905	45,289,832	62,347,081	107,636,913	(100,949,008)
8-14 days	6,245,494	368,400	6,613,894	35,097,867	2,671,425	37,769,292	(31,155,398)
15-28 days	10,089,421	-	10,089,421	34,129,892	12,926,268	47,056,160	(36,966,739)
29-3 months	43,069,022	43,168,616	86,237,638	128,802,454	15,102,693	143,905,147	(57,667,509)
3-6 months	37,436,803	19,475,685	56,912,488	98,147,190	24,550,604	122,697,794	(65,785,306)
6-12 months	51,190,708	31,694,415	82,885,123	192,640,064	10,020,585	202,660,649	(119,775,526)
1-3 years	193,093,925	56,155,228	249,249,153	35,536,058	14,750,088	50,286,146	198,963,007
3 -5 years	61,576,756	85,004,308	146,581,064	89,478,067	2,463,321	91,941,388	54,639,676
>5	58,393,688	193,893,769	252,287,457	4,465,937	64,389,407	68,855,344	183,432,113
	469,995,663	429,760,421	899,756,084	669,555,852	209,221,472	878,777,324	20,978,760

Source: Annual Report Yes Bank 2013

Comparing the tenure of Assets and Liability

The table below compares the tenure of assets and liabilities of Yes bank. The mismatch between the Assets and Liabilities tenure is there for all to see. Hence interest income which depends on assets will be repriced after the interest expenses which depends on the liabilities. Thus, banks such as Yes Bank might see negative Net Interest from income if banks continue to increase interest rate. In other words, these banks will earn losses from NII. Interest Income is approximately 87% of the total income for Yes Bank. This  shows the dependence of the bank on  Interest Income. Hence, if net interest becomes negative the bank is in deep problem.   

ALM Bucket	Assets in the category to total assets	Liability in the category to toal liabilities
1 day	0.25%	1%
2-7 days	0.74%	12.2%
8-14 days	0.74%	4.3%
15-28 days	1.12%	5.4%
29-3 months	9.58%	16.4%
3-6 months	6.33%	14.0%
6-12 months	9.21%	23.1%
1-3 years	27.70%	5.7%
3 -5 years	16.29%	10.5%
>5	28.04%	7.8%
	100.00%	100.0%

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +